F105 Eco

The Economics of Property and

Construction

Assignment 1

Prepared by: Andrew Lyle

Student no: 0704774

Submission date: 1st April 2014

Word count:

Question 1 a
Question 1a asks us to explain with the aid of demand and supply
diagrams the likely effects of a large increase in construction workers
wages upon the market for labour-saving construction machinery.
It is assumed that a firm has a desire to maximise its profits and all
decisions the firm will make will be to reach this goal.
The resources that a firm demand which are known as the inputs include
human effort (labour), equipment or tools (capital) and materials
(intermediate), are all inputs that a firm uses for its production of its
outputs, for example a building contracting company will be the demander
and the tradesmen will be the inputs.
A firms demand for resources (inputs) is dependant on the demand for
the outputs which those resources can be used to produce, this is known
as derived demand, inputs are only demanded by a firm only if there is a
demand for the good or service produced by the firm.
The inputs productivity is measured by the amount of output produced by
each unit of that input. Inputs can be complementary or substitutable.
This means the firms input demands are closely linked together, if there
was a large increase in construction worker wages, the firms demand for
labour would fall and its demand for labour saving construction machinery
would increase. In the short run the firm would probably look to absorb
the additional costs due to time restraints implementing redundancy or
purchasing new capital equipment, however in the long run the firm would
look to maintain its profits by substituting labour with capital (labour
saving construction machinery).
If it is possible for the firm to substitute one input for another, reducing
total costs but maintaining output, then the firm should make the
substitution. As stated in (Lipsey and Crystal 2011) such cost-reducing
substitutions are always possible whenever the marginal product (MP) of
one input per 1 spent on it is greater than the marginal product of the
other input per 1 spent on it.
The law of demand states that, if all other factors remain equal, the higher
the price of a good, the less people will demand that good, this is the
same for inputs, the higher the price of the input the less a firm will
demand. Figure 1 below shows a typical downward sloping demand curve,
as the wage rate increases, the demand for labour reduces. At wage level
1 (W1) 10 per hour; the employer would employ 90 workers, this would
be reduced to 50 workers if he had to pay 15 per hour (W2).

Figure 1 - Demand curve

The increased labour costs will cause the demand curve to shift to a new
position from D1 to D2 in response to the change in the variables. The
decrease in demand for labour will result in a shift to the left of the
demand curve.
Figure 2 Shift in demand curve

As previously mentioned, it is possible for a firm to substitute one input for

another, therefore as the demand for labour decreases due to increased wages,
there will be an increase in the demand for labour saving construction machinery.

Figure 3 Demand for labour saving machinery

The increase in demand for labour saving machinery will cause the
demand curve to shift to a new position from D1 to D2 in response to the
change in the variables. The increase will result in a shift to the right of
the demand curve.
The law of supply demonstrates the quantities that will be sold at a
certain price. But unlike the law of demand, the supply relationship shows
an upward slope. This means that the higher the price, the higher the
quantity supplied.
Figure 4 - Typical supply curve

Figure 5 below shows the results when a rise in demand occurs with the
supply unchanged. Where the demand for labour saving machinery has
increased from 3 to 6, it has caused a shift in the demand curve, which in
turn has caused a short term excess demand, with the demand exceeding
the market equilibrium E1.
During this period of shortage, buyers of the labour saving machines will
compete for the quantities available, bidding up the price in the process,
this will continue until a new market equilibrium price is reached E2, which
in this example is 5 machines at approximately P 5.25
Figure 5 The effect of a rise in demand on market equilibrium

From the above it could be concluded that a large increase in construction

worker wages will cause an initial short supply of labour saving machinery
followed by an increase in its cost, however within the construction
industry, capital is not a good substitute for labour. Many of the tasks
within construction are very labour intensive, for example the repairs and
maintenance sector accounts for one third of the work in the industry.
Replacing labour with capital would be very expensive, there would be the
initial purchase of the capital goods, there would be the storage costs of
the goods between job and the transportation costs. There would be
certain tasks that cannot be replaced by one piece of equipment, if we
look at a general labourer, you would need to find a machine that could
carry bricks, sweep the floor and make the tea! Within the construction
industry, the substitution of capital for labour is confined to about one fifth
of the industry, and with the conditions of the industries work, the price of
capital compared to labour remains high.

In conclusion there would be very little demand for labour saving

construction machinery.

Question 1b
Question 1b asks us to explain with the aid of demand and supply
diagrams the likely effects of a large increase in construction workers
wages upon the housing market.
In the short run an increase in construction worker wages would have very
little impact on the housing market, this is because the housing market is
primarily inelastic.
There are two main reasons for the inelasticity in the short run housing
market; the first being that most speculative building firms react to the
market rather than basing their decisions on forecasts, it will take time,
possibly several months for these firms to realise that there is an increase
in demand, and would possibly take them several further months to react,
as they would have to design, possibly obtain planning consent and then
eventually build the house. The second reason being, that the existing
housing stock is so large, any annual flows and additions to the housing
stock would unlikely be of any significance in relation to the number of
houses overall.
If there was a large increase in construction worker wages, the building
firms would initially find their firms less profitable and would be more
cautious is starting any new developments, this would lead to a reduction
in the number of construction workers employed, and subsequently fewer
houses being build.
The increased labour costs will cause the demand curve for labour to shift
to a new position in response to the change in its variables. The decrease
in demand for labour will result in a shift to the left (decrease) of the
demand curve.
Figure 6 - Reduction in labour demand curve

In the mid to long term as the firm decreases its size of workforce to compensate
for the increase in wages S1 to S2, the number of developments supplied by the
firm reduces from Q1 to Q2, causing a shift to the left of the supply curve.
Figure 7 Reduction in the number of developments

During this period of shortage the demanders of the housing market will
compete for the quantities available, bidding up the price in the process,
this will continue until a new market equilibrium price is reached. Figure 8
demonstrates that when the supply in housing decreases and shifts to the

left the new market equilibrium shows a reduction of new developments

but at a higher cost E1 to E2.
Figure 8 - Effect on market equilibrium from a decrease in supply

It can be concluded that a large increase in wages within the construction

industry would initially have very little impact on the housing market,
however in the longer run there would be an increase in house prices as
new homes become scarcer.